Implementation of IFRS 5 can be a complex and time-consuming exercise with significant judgment required, explains Graham Holt
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This article was first published in the January 2017 international edition of Accounting and Business magazine.
Over the last few years, the Interpretations Committee of the International Accounting Standards Board (IASB) has been considering certain issues relating to IFRS 5, Non-current Assets Held for Sale and Discontinued Operations. This article discusses some of those issues.
IFRS 5 requires an entity to classify non-current assets as held for sale when the assets' carrying amount will be recovered principally through a sale transaction rather than through continuing use. The standard further sets out more detailed conditions that an entity has to meet within the context of a typical sale transaction.
These conditions include: a commitment to a plan to sell the asset; the asset being available for immediate sale; and the sale being highly probable within a 12-month time period. When an assets is classified as held for sale, the entity has to measure the asset at the lower of its carrying amount and fair value less costs to sell. At first sight these conditions and accounting practices seem straightforward but several issues have arisen since the standard was introduced.
One issue relates to whether loss of control other than through outright sale can result in a held-for-sale classification. For example, an entity could lose control through dilution of the shares held by the entity or due to call options held by a non-controlling shareholder.
The question therefore is whether ‘loss of control' is a factor that brings the event within the scope of IFRS 5, or whether there also needs to be a disposal. The loss of control is a significant economic event that meets the IFRS 5 requirements, and triggers the held-for-sale classification, provided the other relevant criteria are met. This is regardless of whether the entity will retain a non-controlling interest in its former subsidiary after the sale. This means that the recovery of the carrying amount of non-current assets or disposal group has changed to a method other than continuing use.
It is argued that the current objective of IFRS 5 is to capture non-current assets (or disposal groups) over which an entity is committed to lose control, irrespective of the form of the transaction other than abandonment. Additionally, the non-current assets (or disposal group) must be available for immediate disposal, and it must be highly probable that the entity will lose control. The loss of control is a significant economic event and information about the event helps users to assess the timing, amount and uncertainty of an entity's future cashflows.
Another issue relates to whether an impairment loss recognised for a disposal group should be allocated to non-current assets in the group to the extent that it reduces the carrying amount of such assets to below their fair value less costs to sell. The Interpretations Committee has discussed this issue and noted that in determining the order of an impairment allocation to non-current assets, IFRS 5 does not refer to IAS 36, Impairment of Assets, which states that an impairment loss for a CGU (cash-generating unit) should not reduce the carrying amount of an
asset below the highest of:
- its fair value less costs of disposal (if measurable)
- its value in use (if determinable)
As a result, the Interpretations Committee has tentatively stated that IAS 36 does not affect the allocation of an impairment loss for a disposal group. However, it is still unsure as to whether the amount of impairment losses should be limited to: the carrying amount of the non-current assets measured under IFRS 5; the net assets of a disposal group; the total assets of a disposal group; or the non-current assets with the possible recognition of any liability for the excess.
The interpretation of the definition of ‘discontinued operation' has come under scrutiny, particularly with regard to the concept in IFRS 5 of ‘separate major line of business or geographical area of operations'. IFRS 5 says that a discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale and meets certain conditions, two of which are part of a single coordinated plan, and that the discontinuance ‘represents separate major line of business or geographical area of operations'.
This latter concept can be interpreted differently depending on how the entity determines its operating segments. Generally speaking, the disposal of a reportable segment will be the type of strategic shift that qualifies as a discontinued operation. The definition of discontinued operations is an area that the IASB has attempted to revise, but the issue has not yet been resolved.
There are different practices as regards how transactions between continuing and discontinued operations are treated. Some entities eliminate the transactions in full without any adjustments, while others eliminate with adjustments to reflect how transactions between continuing or discontinued operations will be reflected in continuing operations going forward.
Finally, some entities do not eliminate such transactions. IFRS 5 attempts to address this issue by requiring an entity to ‘present and disclose information that enables users of the financial statements to evaluate the financial effects of discontinued operations and disposals of non-current assets (or disposal groups)'.
The standard itself does address how to reflect the impact of transactions between continuing and discontinued operations, but some believe that IFRS 5 requires adjustments to reflect the anticipated impact of the disposal to be included on the income statement itself rather than providing additional information in the notes.
The Interpretations Committee discussed this issue and concluded that there were no requirements or guidance in IFRS 5 or IAS 1, Presentation of Financial Statements, in relation to the presentation of discontinued operations that could override the consolidation requirements in IFRS 10, Consolidated Financial Statements. At this point, the committee agreed that an entity was required to eliminate intra-group transactions in full prior to determining the presentation of continuing and discontinued operations. However, subsequently the committee felt that this and other issues were too broad for it to address, which indicated that a broad-scope project on IFRS 5 was necessary.
In 2013, IFRS 5 was amended to clarify the situation where a disposal group or non-current asset ceases to be classified as held for sale and is a subsidiary, joint operation, joint venture, associate or a portion of an interest in a joint venture or an associate (subsidiary et al). However, for a non-current asset (or a disposal group) that is not a subsidiary et al, ceasing to be classified as held for sale results in the inclusion of any measurement adjustment in profit or loss in the current period.
In contrast, if a change to a sale plan involves a subsidiary et al, then IFRS 5 requires retrospective amendments. Questions have arisen as to why there is inconsistency between the two treatments and whether retrospective amendment applies not only to measurement but also to presentation. The Interpretations Committee felt that the retrospective amendment should apply to both measurement and presentation aspects of financial statements but because there was no observable diversity in practice, it has not taken this any further.
Another issue relates to a situation in which an impairment loss recorded for a disposal group that is classified as held for sale subsequently reverses. IFRS 5 requires the recognition of a gain for a subsequent increase in fair value less costs to sell of a disposal group. However, specifically, the question focuses on whether an impairment loss relating to goodwill can be reversed.
Guidance on the reversal of an impairment loss for goodwill generally is set out in IAS 36, which states that an impairment loss recognised for goodwill should not be reversed in a subsequent period. IFRS 5 includes multiple references to IAS 36 but omits any reference to the above requirement. By not recognising a reversal of an impairment loss for goodwill, it essentially means that the disposal group is seen as comprising separate assets and liabilities, which are subject to different measurement requirements within IFRS.
If the disposal group is seen as a single asset or liability, then the recognition and measurement requirements should be applied to the disposal group as a whole, rather than the individual assets and liabilities. The Interpretations Committee has discussed this issue three times at its past meetings and could not reach a consensus.
Another issue is whether IFRS 5 applies to a disposal group that consists mainly, or entirely, of financial instruments. IFRS 5 states that financial assets are excluded from its scope for measurement purposes. This issue is particularly relevant where the disposal group is expected to be sold at a loss. In applying the requirement of IFRS 5, it is possible that the loss is recognised only when the sale effectively occurs and this conflicts with the measurement principles in IFRS 5, which require measurement at fair value less costs to sell at the date of a ‘disposal group' classification. The Interpretations Committee noted that this was another example of the IFRS 5 measurement challenges.
Discontinuing a business operation or deciding to sell a major asset are important commercial events, which are likely to have a significant effect on an entity's results and net assets. IFRS 5 can have a significant effect on a company's profit or loss, the carrying values of its assets and on the presentation of results.
Implementation of IFRS 5 can be a complex and time-consuming exercise with significant judgment required especially in the areas above.
Graham Holt is director of professional studies at the accounting, finance and economics department at Manchester Metropolitan Business School